Why we need to separate the central bank from the monetary authority

[This post is dedicated to the guy who should have won the Nobel Prize]

I’ve occasionally argued that we should simplify the monetary system.  Have the Fed simply issue currency, and adjust the currency stock to target NGDP expectations.  Forget about banking.  Eugene Fama got there first, in a brilliant paper written in 1983 (JME).  Here’s Fama:

Patinkin (1961) shows that the real value of a unit of account can be controlled by controlling the supply of an asset that:

(a)  has no perfect substitutes,

(b)  pays interest at a lower rate than other assets of equivalent risk,

(c)  sells at face value stated in terms of the unit of account.

Obviously currency fits the bill.  Fama then argues:

Because U.S. banks must hold reserves against most of the liabilities (demand deposits, time deposits, certificate of deposit) issued to finance their lending activities, central bankers believe that control of the base implies restrictions of financial intermediation.  Thus, they feel compelled to balance price level control against its perceived implications for financial intermediation.  The yoke is easily broken.  Reserve requirements can be dropped, or, what amounts to the same thing, banks can be allowed to hold reserves in the form of assets that pay free market interest rates.  Price level control can then focus on control of the supply of currency — an innocuous activity that does not impinge on the ability of the economy to finance real activity.

Exactly!  This is why we need to separate the central bank from the monetary authority.  The central bank could be an agency that would regulate banks, set reserve requirements, do interbank clearing of funds, be a lender of last resort during banking crises, etc.  But not monetary policy!  If the Fed really wants to pay interest on the reserve balances, let them.  But then don’t let them do monetary policy.

The monetary authority would adjust the supply of currency to target the price level (Fama’s goal) or NGDP (the market monetarist goal.)  And most importantly that’s all they’d do.  There would be nowhere to hide when things go wrong, as in 2008-09.

Our actual Fed was super busy with all sorts of banking system interventions during the crisis, which is why most economists seem to think Bernanke is some sort of hero who rescued the economy.  The Fed hoped these financial system interventions would help the real economy, but it didn’t, because it had misdiagnosed the problem.  It was falling NGDP that intensified the financial crisis in late 2008.  It was falling NGDP that caused unemployment to soar.

In contrast, the monetary authority would be told to keep NGDP growth at 5%, and pay no attention to banking.  That’s their only job, and they get fired if they screw up.  Their only tool for boosting NGDP would be currency creation (and promises of future currency creation.)

Both the central bank and the monetary authority would send their profits to the Treasury, and both would have any shortfalls from their operations covered by the Treasury.

I’d love to see the monetary authority try to shove a few trillion in $5 bills down the publics’ throats.

PS.  Has anyone noticed that whenever I describe someone’s paper as “brilliant,” it’s because he agrees with me?  But Fama’s paper really is impressive.  Kevin Hoover (who is extremely bright) published a critique in 1988 in Oxford Economic Papers.  But unless I’m mistaken he completely missed the point of Fama’s paper.  Currency is all you need to peg the price level.

PS.  Congratulations to Alvin Roth and Lloyd Shapley.


Tags:

 
 
 

71 Responses to “Why we need to separate the central bank from the monetary authority”

  1. Gravatar of StatsGuy StatsGuy
    15. October 2012 at 05:15

    They did not just misdiagnose the problem, they weren’t even talking the same language.

    I think you are already starting to forget the dialogue back in 08 and early 09. EVERYTHING was about credit as the “lifeblood” of the economy – so intense was this meme that it played through the inaugural address. In the economic meetings, it wasn’t the argument, it was the basis of having any argument.

    You will enjoy this (and by enjoy, I mean relive moments that caused you to pull out your hair).

    http://www.nytimes.com/2009/06/08/us/politics/08team.html

  2. Gravatar of Major_Freedom Major_Freedom
    15. October 2012 at 05:30

    ssumner:

    It was falling NGDP that intensified the financial crisis in late 2008. It was falling NGDP that caused unemployment to soar.

    This is false. The causal direction is the other way around.

    The financial crisis precipitated the fall in NGDP. The financial crisis precipitated a collapse in the value of accumulated savings and capital, and that caused productive expenditures to decline, and that caused unemployment to rise. The subsequent decline in spending from workers and those who pay wages then constituted the fall in NGDP.

    If monetary inflation was higher than it was, then this MAY have prolonged the adjustment in the market prices of accumulated savings and capital, it MAY have prolonged the adjustment in wages and prolonged their fall, and that in turn MAY have prevented NGDP from falling. Unemployment, if it would have been temporarily prevented from falling, would not have been so postponed due to what happens to NGDP, but by that which affects NGDP later on.

    NGDP does not pay wages. It is in part a RESULT of wage payments. Logically, it is possible for the entire sum of NGDP to be constituted solely by consumer spending, with zero capital spending and zero wage payments.

    Wage payments are actually in competition with all other forms of spending, including the components of NGDP. One cannot guarantee a minimum level of wage payments through ensuring that final spending keeps growing at a constant rate. This theory has been both theoretically refuted and empirically falsified. The fact that it is still believed necessarily makes it a dogma or ideology, not economic science.

  3. Gravatar of Josiah Josiah
    15. October 2012 at 05:44

    This post is dedicated to the guy who should have won the Nobel Prize

    Isn’t dedicating a post to yourself a bit gouche?

  4. Gravatar of Major_Freedom Major_Freedom
    15. October 2012 at 05:50

    Suppose NGDP growth is 5% per year for 1,000 years.

    Then one year, for some reason as yet undetermined, wage payments are going to fall to zero.

    Without accelerating monetary inflation, it is almost certain that NGDP is then going to fall (since wage earners are not going to be spending out of any wage income earned this year, since wage income is zero).

    Now suppose that a person who is convinced that NGDP drives employment, believes that he can restore employment by using inflation, and he consciously seeks to raise NGDP above what it otherwise would have been as the means.

    So imagine that this year, he goes out and prints and spends however much money on final output as would be required to keep NGDP growing at 5% per year. Let’s say he prints and gives $10 trillion to a seller of Season 2 of Full House on Blueray (who is by himself in the store because there are no employees…anywhere). Let’s suppose for the sake of argument that this seller fully expected NGDP to grow at 5% this year, but doesn’t know how much of that NGDP will be devoted to spending in his store.

    So NGDP was kept chugging along at 5% growth this year. And yet…unemployment remains at zero.

    Is the theoretician wrong, or is the seller of the Blueray videos wrong for not behaving in the way the printer/spender expected?

  5. Gravatar of Saturos Saturos
    15. October 2012 at 05:59

    Shapley totally deserved the prize, I have no regrets, its about bloody time.

    I don’t know enough about this, but I suspect you’re wrong here, Scott. (Nick Rowe, Bill Woolsey and George Selgin could clarify.)

    Normally both currency and deposits are used as money, and control over the stock of all kinds of money depends on the fact that banks must settle checks with reserve money, constraining the money multiplier. Fama himself says that his argument is meant for a simplified financial system. As long as banks create money, they can increase base velocity and NGDP, pushing up prices with more deposit money. The Fed can control that by manipulating the base, but it can’t ignore the effects of what banks do.

  6. Gravatar of Saturos Saturos
    15. October 2012 at 05:59

    “In my view, the primary reason for the poor performance of the U.S. economy over this period has been inadequate aggregate demand.”

    - William Dudley, NY Fed

    http://www.newyorkfed.org/newsevents/speeches/2012/dud121015.html

  7. Gravatar of johnleemk johnleemk
    15. October 2012 at 06:04

    In other news, NY Fed President William Dudley says the economic crisis is demand-side and caused by tight money: http://www.newyorkfed.org/newsevents/speeches/2012/dud121015.html

    He also echoes the point you make frequently:

    In the long run, even savers would be better off in a world in which aggressive monetary policy generates a strengthening recovery that eventually permits the normalization of interest rates, than they would be compared to a circumstance in which the United States allowed itself to fall into a Japan-style trap of low growth and low rates for decades. So I do not view the effect of low rates on savers as a reason to be less accommodative.

  8. Gravatar of johnleemk johnleemk
    15. October 2012 at 06:04

    Damnit Saturos!

  9. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 06:05

    I still do not see how this would work. Currency is not very relevant, so what would your monetary authority control, really? How would it be connected to the banking system? How would people get currency, if the banks do not intermediate?

    I do not understand the way you think. Banks can create money, do you agree? When I have a credit card and a credit line, I can spend money without any need to hold cash. So I have “money” for all practical purposes, which the monetary authority does not control. If the Fed relinquishes control over interbank payments and reserve deposits, the banks would be unconstrained in their money and credit creation. If you don’t need to make cash payments (and I, for example, rarely do, except for small things), you need never come into contact with the “monetary authority”.

    “I’d love to see the monetary authority try to shove a few trillion in $5 bills down the publics’ throats.”

    How would they do this? Do they give away free money (which I would really call a fiscal operation)? How could the monetary authority “shove” money down my throat? My deposits are in a bank that in your system has no connection to the monetary authority! They cannot force me to convert my deposit into cash, and I don’t want to sell my treasury bills to them. Then what do they do?

  10. Gravatar of johnleemk johnleemk
    15. October 2012 at 06:10

    Shining Raven,

    If printing money is not monetary policy, what is? Why conflate banking policy and monetary policy, while insisting that printing money and giving it away is not monetary policy?

  11. Gravatar of Major_Freedom Major_Freedom
    15. October 2012 at 06:14

    William Silber recently released a biography of Paul Volcker, called Volcker: The Triumph of Persistence.

    Silber writes about Volcker when he was undersecretary of the Treasury for Monetary Affairs during the JFK administration. He quotes Volcker as saying:

    “It all sounded too easy. Push this button twice and out pops full employment. Equations do not work on people as well as they do on rockets. I remember sitting in a class at Harvard listening to [the fiscal policy expert] Arthur Smites say, ‘A little inflation is good for the economy.’ And all I can remember after that was a word flashing in my brain like a yellow caution sign: ‘Bullshit.’ I’m not sure exactly where that came from…but it’s a thought that never left me.” – Paul Volcker

  12. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 06:32

    Hmm, my understanding is that “monetary policy” is what central banks usually do, and that is *not* giving out financial assets for free.

    They usually *loan* out reserves to banks, often secured by treasuries as collateral, which in some sense of course creates more “money” for the bank. Or they swap treasuries for reserve balances. This does not give anybody any additional assets, it only changes the type of assets somebody holds (cash vs. bonds).

    Again, in my understanding, simply *giving* money to somebody is not part of normal monetary operations.

  13. Gravatar of johnleemk johnleemk
    15. October 2012 at 06:38

    Hmm, my understanding is that “monetary policy” is what central banks usually do, and that is *not* giving out financial assets for free.

    The first sentence of the Wikipedia article on monetary policy:

    Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.

    The only way your arbitrarily restrictive definition can be right is if you redefine “the supply of money” as “the supply of credit”, even though the two concepts are not synonymous.

  14. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 06:39

    The monetary system we have works through the banks. There is no way around this. Monetary policy is implemented through the banks. If you want to separate monetary policy from banks, you have to separate money and banks. How is this supposed to work?

    In very practical terms, how would the monetary authority in Scott’s proposal operate? Would it open a branch in every town, and people would get their cash from them? Would people still have accounts at commercial banks? Or would everybody and their cousin bank at the monetary authority directly?

  15. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 06:49

    johnleemk: That is all very well, but how does the central bank do this? It does not give away money for free! To whom would these payments go?

    “targeting a rate of interest” basically says it, no? If I am a bank, I can get money by borrowing it from the central bank against some collateral. Or I can sell some treasuries that I hold to the central bank outright. I am not aware of any operation in which the central bank simply gives out money.

    And yes, basically I believe money is credit. To say that money is only currency is certainly more wrong than saying that money is credit. I will not claim to be an expert, but it seems to me that it is really difficult to pin down what we mean by “money”, otherwise we would not have the different measures M0, M2, M3, …. , and I certainly do not believe that “money” is only the stuff in M0.

  16. Gravatar of K K
    15. October 2012 at 07:06

    “pays interest at a lower rate than other assets of equivalent risk”

    There, of course, is the rub.

    “I’d love to see the monetary authority try to shove a few trillion in $5 bills down the publics’ throats.”

    Lets say they earn 1% more than t-bills. So a trillion earns $10bn/year. By my calculation 200bn fives is a 20′ high warehouse about 200 yards on each side. It needs to be fairly secure, of course, but it’s pretty hard to steel a lot of fives. Fire, water and rats are probably a bigger problem. Sounds to me like it would be profitable.

    Seems, at best, like you found a way to lower the ZLB to the NOLB (Negative One Lower Bound).

    Shining Raven,

    You have to assume that currency has special “non-pecuniary” value as a medium of exchange, and that the government is a monopoly supplier of the stuff that serves *that* particular exchange role. I.e. *nobody* else can provide you with a more efficient (read interest-bearing) way of paying the pizza delivery guy at 2am. The government typically reserves the right to print paper money, but anyways, the market will tend strongly to converge to a single standard for all kinds of efficiency reasons. To make the argument work, though, you need to assume that demand for currency is not totally elastic, an assumption which fails unless currency “pays interest at a lower rate than other assets of equivalent risk.” Otherwise agents will just borrow and hold currency in unlimited quantities. It’s a risk free trade, right? (See my reply to Scott above). You also need to assume that the economy adjusts to an equilibrium that is independent of the outstanding quantity of non-currency nominal assets. You can imagine that happening in an economy that is independent of the wealth distribution (all nominal assets are someone else’s nominal debt so in a representative agent economy debt doesn’t matter). But in the real world, where most agents have binding liquidity constraints (or at the very least, don’t all fund at the same rate), the distribution of debt hugely dominates liquidity effects.

  17. Gravatar of Ritwik Ritwik
    15. October 2012 at 07:24

    K

    I’m sure you meant 1% *less* than t-bills? Apart from that, bravo!

  18. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 07:24

    K,

    thanks for the long answer. I get what in general the point of holding cash is.
    But I am still hung up on the question of the interface between the banking system and Scott’s monetary authority. That is essentially the problem with the “clearing house” separate from the monetary authority that we discussed in the other thread.

    I don’t understand how I or the banks for that matter here get hold of cash, and what its relation to credit would be in this system. If I cannot get cash, then the pizza delivery guy needs to get a credit card reader, and we can do the transaction without cash.

    Then how does Scott’s proposal constrain the ability of my bank to extend credit, and of myself to spend “money”?

    The big question for me is the one of the relation between the monetary authority and the banking system: If I have a deposit at a commercial bank, how can this be converted to cash if I want to withdraw this? What is the relationship between my deposit and the “money” that the monetary authority
    issues? This is completely unclear to me.

    I don’t really understand your last point, or at least I don’t see the implications of what you are saying. How does the distribution of debt come in?

  19. Gravatar of Ritwik Ritwik
    15. October 2012 at 07:27

    And also, the cost of running that warehouse seems more of the order of $100 million than $10 billion.

    So actually, it’s the negative one basis point lower bound. (NOBPLB).

  20. Gravatar of Major_Freedom Major_Freedom
    15. October 2012 at 07:31

    Shining Raven:

    The monetary system we have works through the banks. There is no way around this. Monetary policy is implemented through the banks. If you want to separate monetary policy from banks, you have to separate money and banks. How is this supposed to work?

    In very practical terms, how would the monetary authority in Scott’s proposal operate? Would it open a branch in every town, and people would get their cash from them? Would people still have accounts at commercial banks? Or would everybody and their cousin bank at the monetary authority directly?

    I’m with Shining Raven.

    It makes no sense to work for the benefit of the initial civilian receivers of money, and for the legalized counterfeiters only indirectly. We should all just work for the benefit of the counterfeiters directly and cut out the middlemen bankers.

    Bankers created the centralized banking cartel, for the benefit of the banks, so it should be very easy to convince them to give that power up and willingly start financing the campaigns of politicians who will cut out the banks.

  21. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 07:42

    Well, I am not really sure I meant that as an actual proposal. Only one central state bank where everybody banks? Sounds like communism.

  22. Gravatar of Major_Freedom Major_Freedom
    15. October 2012 at 07:50

    Shining Raven:

    Well, I am not really sure I meant that as an actual proposal. Only one central state bank where everybody banks? Sounds like communism.

    Oh don’t worry, we can avoid the dreaded Communism label by having this central bank designate a portion of its authority to a privileged group of local bankers dispersed across the country, who are given the authority to issue their own money called fiduciary media, or credit, but only as long as they obey the central bank authority’s rules. You can go ahead and choose any of these subsidiary authorities to do your banking with. You don’t have to deal with the headquarters directly.

    These local banks should not be able to create hard currency however, because that may lead to hyperinflation more easily. The power to create hard currency must remain with the central bank authority only.

    So what you think of this new, not currently existing monetary system?

  23. Gravatar of Bonnie Bonnie
    15. October 2012 at 07:59

    I agree that monetary policy should be distinct from at least banking regulation. Barney Frank was trying to get a separation between them in the Dodd/Frank legislation, but it didn’t go anywhere. Subsequently, he was trying to have the regional Fed Presidents stripped off the FOMC – also didn’t go anywhere. Alternatively, Congress could amend Humphrey-Hawkins to clarify the meaning of the mandates, impose level targeting, and introduce accountability. That might help if they can’t come to an agreement regarding the erection of a wall between the two functions.

  24. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 08:00

    M_F:

    Now your pulling all six of my legs, aren’t you? “New, not currently existing monetary system”? Yeah, right.

    I am still curious to hear about the practicalities of Scott’s proposal, because I genuinely do not understand how this is supposed to work.

  25. Gravatar of Sir Thomas Gresham Sir Thomas Gresham
    15. October 2012 at 08:03

    Shining Raven,

    There is a simple way to do it. Just separate the system of domestic and international payments from all financial intermediation. Payments are debits from accounts that are in turn credited by the payee (today there are many ways to debit an account, mainly electronically). The consolidated balance of all accounts is determined by the Authority (say the Treasury) so the accounts are backed by the power to tax. Cash is not different: your pocket’s Authority-printed bills are in your personal account that you manage yourself and when you pay the payee “credits” in his/her own pocket account.

    You can run a system of payments totally separated from all financial intermediation, in particular that involving borrowing and lending which include many types of credit, including credit cards to borrow from pre-approved lending. Today there are many financial companies that are not banks and the only reason to separate banks from other financial companies is because of their involvement in the payments system.

    Indeed, you may go to the store and “pay” with your credit card, but analytically this amounts to two separate transactions –one in which your lender has pre-approved you a loan (remember that the lender charges you a fee for committing funds), and the other one the lender’s payment to the store on your behalf. If you had paid with your debit card (or cash) there was just one transaction.

  26. Gravatar of bill woolsey bill woolsey
    15. October 2012 at 08:07

    I don’t agree with this proposal nor with Sumner’s currency-centric views.

    Still….

    The way the monetary authority issues currency would be by purchasing government bonds in exchange for newly printed currency. It would withdraw currency from circulationg by selling government bonds for currency.

    Each bank would still be tied to currency by an obligation to redeem its deposits with currency.

    This supposed central bank that imposes reserve requirements, manages the clearinghouse, serves as lender of last resort to banks, would necessarily be restrained because its the banks it is regulating, serving, or whatever you want to call it, would all be required to redeem their liailibilites for currency.

    It would be natural for the central bank to also be required to redeem its liabilities for currency, but I suppose one could imagine a system where there was no such requirement. (But I think that quickly leads to a parellel clearing system among banks that settles up with currency. What would be the point?)

    Anyway, as long as there is a demand for currency, the monetary authority can keep nominal GDP from rising above target. As long as the monetary authority can purchase enough assets (government bonds, in the first instance) it can get nominal GDP up to target.

    The banks and the central bank might change their demand for currency (as can households and other firms,) and the monetary authority must simply adjust the quantity enough to offset these changes.

  27. Gravatar of Saturos Saturos
    15. October 2012 at 08:27

    K, what makes you think that “bearing interest” is the reason why Federal Reserve money is the most efficient way of paying the pizza guy?

    And interest rates aren’t going to be zero forever. If they were, then we should start dropping money out of helicopters. Or target higher trend inflation in the first place.

    Honestly, how can anyone who’s seen Svensson and Christensen’s “foolproof” mechanisms still believe in liquidity traps?

    Shining Raven, the point was about holding money, not cash per se – so I think you still don’t get it. When a bank extends credit that corresponds to a commitment to pay base money to another bank on demand. Same goes for your credit card – it allows you to defer your payment of money (via the credit card company). Money is the medium of exchange (and naturally also tends to be the numeraire, or medium of account).

    Ritwik, I’m pretty sure he didn’t.

    Johnleemk, did you see the Yahoo! Finance tweet as well? Also:

    Nya-nya-nya-nya-nyah.

  28. Gravatar of Major_Freedom Major_Freedom
    15. October 2012 at 08:27

    Shining Raven:

    Now your pulling all six of my legs, aren’t you? “New, not currently existing monetary system”? Yeah, right.

    You got me. But did you get what I am saying? Our monetary system is pretty much the textbook definition of communist planning.

  29. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 08:28

    bill woolsey:

    thanks for the response, this is getting somewhere.

    Now, how would the “central bank” be able to act as a lender of last resort for the banks, if all bank deposits are required to be convertible to currency, but the “central bank” is not the monetary authority and cannot in fact issue currency?

    And if you require this of the member banks, then of course the deposits that they hold at the central bank must be convertible to currency as well. How could it be otherwise? If bank deposits must be paid out in currency, then banks must settle their interbank payments with currency as well, otherwise there would be a severe mismatch between their assets and their liabilities.

    And then we are back at the system we have, with the additional wrinkle that the central bank cannot issue currency and cannot prevent bank runs, i.e. act as a lender of last resort, because it can’t issue currency. It might even be itself subject to a run, when the banking system as such is short on currency reserves.

    To me, this sounds pretty dysfunctional.

    The central problem to me seems to be that on the one hand, reserves are required to settle payments, and the system breaks down if there is not enough liquidity. So the reserves are determined by the system itself. On the other hand, market monetarists want to restrain banks from creating money by trying to impose hard limits on the amount of reserves in the system. This clearly is in tension with a functioning payment system. So far, I have not seen an idea to resolve this essential tension.

  30. Gravatar of Saturos Saturos
    15. October 2012 at 08:29

    I think Bill was sort of agreeing with me there. Not sure, though.

  31. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 08:30

    M_F: yes, I got what you are saying, and you do have a point, although I would not fully subscribe to your conclusion. Seems more like a severe case of regulatory capture.

  32. Gravatar of Saturos Saturos
    15. October 2012 at 08:34

    Shining Raven, Market Monetarists begin with the desired level of total spending, then adjust the base to offset changes in base velocity, keeping an eye on the forecast to stay on target. Banks will try to make as many loans as they can, so that will press the money multiplier up, but if necessary we will reduce the base. If money is defined as say M2, then yes too much M2 will cause us to overshoot our NGDP target, so we reduce M0, which reduces M2. Not sure what’s wrong with that though. Financial intermediation still proceeds as required in real terms; its purely the nominal variables we’re controlling.

  33. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 08:38

    Saturos: No, I do get that. Of course, in the existing system, when I pay something by credit card, my bank settles with the bank of the receiver of the payment by using “base money”, i.e. reserves. Not cash, usually.

    But Scott wants to decouple this function from the monetary authority. The “central bank” becomes purely a clearinghouse for interbank payments, and currency is issued by the monetary authority.

    But then the deposits of the banks at the “clearing house” (or “reserves”) are decoupled from currency. They are a new kind of “central bank money”, created by this clearing house and the participating banks, when they extedn each other credit.

    In order for the monetary authority to retain control, there needs to be a connection between currency (because that is the only thing that Scott’s monetary authority controls) and the interbank settlement mechanism. You could get that by requiring the banks to settle in currency, but I am not really sure that you can make that stick if you are not the clearing house.

  34. Gravatar of Saturos Saturos
    15. October 2012 at 08:44

    Yes, that’s what I can’t make sense of in Scott’s proposal as well. And I think Bill agrees with us too. I think Fama might have too, I suspect Scott is taking things out of context there. Need Nick and George to weigh in.

  35. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 08:46

    Saturos: The problem that I see is that you cannot arbitrarily impose a hard limit on M0 without breaking the interbank settlement mechanism at the Fed. You’ll get bank runs and failing banks if the Fed does not supply the liquidity necessary to settle interbank payments. If banks do not have sufficient reserves, they obviously cannot make interbank payments, even though their customers see sufficient deposits in their accounts.

    So if you start do decrease M0, what are banks supposed to do? They already have all these deposits, and M2 is what it is, so when you force down the reserve in the system, they cannot make their payments -> bank failures follow.

    If you impose a “soft” limit, how do you do this? Raise the price of getting reserves! Great, we are back at an interest rate policy, as before!

  36. Gravatar of Saturos Saturos
    15. October 2012 at 08:47

    Josiah, seriously, where would be the best place to bet on Scott winning it 20 years from now?

  37. Gravatar of Saturos Saturos
    15. October 2012 at 08:53

    Shining Raven, the Fed (used to) contract the base money supply all the time, by raising the FF rate. What it was really doing was trading bonds for reserves in the overnight market, sucking them out of the system and raising the equilibrium rate. Or simply threatening to do so.

  38. Gravatar of Saturos Saturos
    15. October 2012 at 08:54

    That was when they worried about getting too much inflation. Of course, no one worries about that these days…

  39. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    15. October 2012 at 09:05

    Is Scott reviving Friedman’s 100% reserve banking idea?

  40. Gravatar of Saturos Saturos
    15. October 2012 at 09:12

    I thought Friedman’s idea was to freeze the base?

  41. Gravatar of K K
    15. October 2012 at 09:14

    Shining Raven,

    Lets assume you suddenly feel like holding more currency. You come to the bank requesting a “withdrawal” of currency from your account. The bank goes to the t-bill/currency market and sells some t-bills. They give you your currency and cancel your deposit. Because of the additional demand for currency, the t-bill currency market will now clear at a higher yield on t-bills. If the monetary authority does not desire this, they will buy some t-bills, thereby creating more currency. Scott would tell this story without *any* reference to the t-bill yield. He would just say:

    “if NGDP futures are trading below target, the monetary authority buys some more assets, thereby putting more currency into circulation. Forget about debt – it’s a net-zero asset in the economy, unlike money which is a *real* asset because of its value as an exchange medium. There is only one nominal asset: currency. Now think about Hume’s thought experiment where we suddenly double the quantity of currency. Assuming the doubling is permanent, obviously we go back to the *identical* equilibrium with all prices doubled.”

    This is true. But in a world with debt, achieving the *same* equilibrium also requires a doubling of all debt contracts, right? But that doesn’t happen automatically at all. Instead rates drop to zero. Then *if* inflation ensues, we a huge wealth transfer from creditors to debtors, ultimately wiping out half the value of debt. Because the creditors are sometimes (currently) extremely credit constrained this will have a very large impact on their behavior (creditors and debtors don’t consume or invest in the same patterns) and you wont get back to the old equilibrium at all. Now imagine *instead* that rates drop to zero, but it’s still now low enough to cause inflation, and instead you get a debt-deflation *disequilibrium* panic spiral caused by excessive service costs on outstanding debt (this dynamic is unlikely to occur in the absence of a large outstanding quantity of debt). Nobody cares about the doubling of currency. The quantity of debt is 100X the quantity of currency anyways. Forget about equilibrium because *first* we are having a Great Depression.

    Standard models assume no limit to borrowing and everybody funds at the same rate. Under those conditions you can imagine why debt-deflation is not an issue. Current debt distribution is simply irrelevant in the very long run under those conditions. Not so, back in the real world. If you want to see how this works in theory check out Eggertsson and Krugman (2010).

    “If bank deposits must be paid out in currency, then banks must settle their interbank payments with currency as well”

    I don’t think so. Lets imagine a systemic bank run causing a shortage of currency. Immediately NGDP futures would plummet (bank runs are *bad*). So the monetary authority would supply more currency. An individual bank could definitely run out of currency. Too bad for them. But I can’t envision a systemic shortage.

    One more thing: from a theoretical macro perspective, Scott’s framework achieves nothing over the standard interest rate framework, except possibly for the part about positive beta asset purchases (NGDP futures). Control of currency = control of the short rate.

  42. Gravatar of Mike Sproul Mike Sproul
    15. October 2012 at 09:31

    Scott:

    Peel’s Bank act (1845 or so) separated the Bank of England into a department that issued money, and a department that conducted banking. Didn’t make much difference.

    Would your Department of Issue get bonds in exchange for its money? Or would it just do helicopter drops?

  43. Gravatar of Around the Web: Nobel Prize Edition « Notes On Liberty Around the Web: Nobel Prize Edition « Notes On Liberty
    15. October 2012 at 09:33

    [...] Why we need to separate the central bank from the monetary authority. [...]

  44. Gravatar of Peter N Peter N
    15. October 2012 at 09:35

    Speech given today by

    The Recovery and Monetary Policy

    William C. Dudley, President and Chief Executive Officer

    Federal Reserve Bank of New York

    http://www.newyorkfed.org/newsevents/speeches/2012/dud121015.html

    “One reason that monetary policy may have been less powerful than normal is that one of the primary channels through which monetary policy influences the real economy—housing finance—has been partially impaired. This has both quantity and price dimensions. Credit availability to households with lower-rated credit scores remains limited and households with homes that have fallen sharply in value have lost most or all of their home equity and this makes it very difficult for them to refinance these mortgages.

    Federal Reserve MBS purchases have succeeded in driving down mortgage rates to historically low levels. But these purchases would have had still more effect on the economy if pass-through rates from the secondary market to the primary market had been higher. …”

    Thanks to FT Alphaville which has a discussion of this:

    ftalphaville.ft.com

  45. Gravatar of ssumner ssumner
    15. October 2012 at 09:42

    Saturos, I’m not claiming the monetary authority would be able to ignore changes in the demand for currency.

    Shining Raven, They’ll be able to find people to sell T-securities in the NYC bond market.

    K, The $5 bill aside was a joke, it obviously doesn’t solve the zero bound problem at a theoretical level. I refer you to my post saying “helicopter drops” won’t work, but helicopter drops would work. In other words, Fed financed tax cuts won’t work, but actual dropping of billions out of a helicopter will work. It was in the spirit of that post. :)

    Patrick, No, I oppose 100% banking.

    Saturos, If there was a bank run the Monetary Authority would have to inject enough cash to prevent NGDP from falling. I’ve been saying that for 4 years, and now you are telling me Dudley agrees? I can’t wait to check that out!

  46. Gravatar of Bill Woolsey Bill Woolsey
    15. October 2012 at 10:14

    The central bank sells its own debt, guaranteed by the Treasury, to come up with funds to lend to member banks.

    It can sell those bonds for currency and had currency over to the banks.

    If there was an increase in the demand for currency, then the monetary authority increases the quantity by purchasing bonds, not necessarily the bonds of the central bank, paying with newly printed currency.

    Sumner is not advocating 100% reserves.

    Sumner is not advocating freezing currency.

    The quantity of currency adjusts to the amount demanded.

    If people pull currency out of some banks and then deposit it in other banks, this is not an increase in the demand for currency (other than to a slight degree, and they could instead write checks on their current bank and deposit them in the new bank.)

    Only if people choose to hold more currency rather than any deposit would a run lead to an increase in the demand for currency and the quantity of currency would need to be increased.

    It looks to me that Sumner’s proposal is perfectly consistent with a flexible quantity of clearing balances. But I don’t think that a less than perfectly flexible quantity is a disaster.

    I think much of the supposed disaster is the inability to make large financial transactions quickly and “excessive” fluctuations in short term interest rates.

    If someone wants to be able to clear a multi-billion dollar payment today (presumably because they want to sell something at 2:00 and then buy at 2:01) then a system where the payment takes time to clear, would be a problem to them. They sell, the funds are wired to their account, but the bank cannot collect from the buyers bank immediately, but rather the funds are only delivered over several days. Well, then they cannot spend the money right away. How can you take account of “arbitrage” opportunities that only last a few minutes or hours?

    If we have banks trying to obtain the needed funds ASAP, then short term interest rates might fluctuate quite a bit. This would be inconvenient to people who can and do fund their activities by borrowing very short.

    In other words, it looks to me that these concerns are all about the special concerns of finanical traders on Wall Street.

    In my opinion, stabilizing short term interest rates by adjusting the quantity of reserves is the goal of the Fed. The contraint is that they cannot cause too much CPI inflation or cause the unemployment rate to rise too much. Those are constraints because politicians care about them, and politicians care about them because voters care about them.

    Why the CEP deflator? Voters care about that. Who but economists cares about the GDP deflator? Why unemployment? Voters care about unemployment. But, of course, if most voters stop caring, then, what’s the problem.

    In my view, the special interests driving the Fed are those who want to see short term money rates stay stable. The “horrible” consequences of a failure to target interest rates are not so horrible. They are just inconviences for Wall Street.

    Of course, if there is a large increase in the demand for currency that is not accomodated, that does generate an economy wide disaster–a drop in nominal GDP and real output.

    But that is a “public bad” as is inflation. No special interest is focused on that.

  47. Gravatar of Lars Christensen Lars Christensen
    15. October 2012 at 10:38

    Scott, this is one of your best posts in a very long time. We need to convince people that central banking really is not about banking. The cb could in reality completely stop interacting with commercial banks and instead just increase and decrease the money base to hit a certain nominal target. Maybe that actually would make it a lot easier to understand that monetary easing (when needed to ensure the nominal target) is not bailing out of certain institutions.

  48. Gravatar of K K
    15. October 2012 at 10:43

    Bill,

    If there was an inefficient level of volatility in the short rate resulting in mean reversion of short term debt instruments, the demand for currency would rise in order to arbitrage it, resulting in downward pressure on NGDP. So the monetary authority would supply more. Apart from that, agree with everything you say.

  49. Gravatar of Gabe Gabe
    15. October 2012 at 11:07

    Sorry to break it to you. Griffin explained it pretty clearly las tweek. The first priority of the Fed IS the banks…the masses are not a big concern.

    So I don’t expect the Fed to pick up on this advice of yours Sumner…good luck in your intellectaul awakening.

  50. Gravatar of K K
    15. October 2012 at 11:10

    Overall, assuming reduced de facto public support for banks, the demand for currency would rise, meaning greater public seigniorage profits. Not my favorite way to deleverage the banks but not a terrible step either. Certainly helps to clarify and separate the various institutional functions. Personally I’d prefer to totally cut the banking system loose and let them figure out their own clearing. I it would be better to let the cb just worry about the unit of account and leave the exchange medium up to the private sector.

  51. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 11:28

    K,

    thanks for the extensive reply. Yes, certainly it would work if the banks settle with t-bills, but then you have to rely on the monetary authority to always swap them for currency. Scott does not say if he envisions this as the policy.

    And I don’t think a settlement system that can leave them easily short of required currency reserves and causes them subsequently to fail would be acceptable to the banks. You say they would fail, to bad for them (I agree with the analysis, if they use anything but currency to settle). But Scott says there is a lender of last resort (not the monetary authority), so he seems to have something different in mind.

    I also agree with your final analysis that the scheme proposed achieves much over the existing system.

    Bill, I agree with the analysis that this would really change the kinds of payments that you can make. But I am not sure if this would only affect Wall Street. Could be a problem for enterprise as well. It certainly would change the way we do business.

    Scott, I still do not see how the monetary authority can “shove money down peoples throats.” It still works only if there is somebody who wants to sell his t-bills for currency. It is entirely voluntary, and people only take the cash if they want it. What is the difference, what can your monetary authority do to get currency into the system that the Fed can’t do?

  52. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 11:30

    oops, of course I meant

    …scheme proposed achieves *not* much over the existing system…

  53. Gravatar of Bill Woolsey Bill Woolsey
    15. October 2012 at 12:53

    Shining Raven:

    You assume that a bank that fails to settle on demand fails.

    We actually have had laws like that. I think the purpose of such laws was to make failure to pay on demand so costly that banks would hold lots of reserves.

    But the policy was not ever really implemented. It was an empty threat and it was a stupid rule.

    It is much better to have some more modest penalty for banks that cannot pay off on demand.

    Now, once you realize that it may take time for banks to raise the cash to cover a payment, then what are the concequences?

    Well, large and rapid finanical trades become impossible. Sell a bunch of assets and then immediately buy them back or something else because impossible.

    OK, how important is that really?

    Do banks really have to let their finanical customers write checks on money that was deposited before the money clears?

    Suppose trades have to be unwound? What is the cost? Does it mean that people devote less resources to exploiting small changes in asset prices?

    Why making sure people do alot of trading important?

    The right way to trade is to buy and hold based upon fundamentals.

    Suppose these deviations of price from full information levels lasts for days rather than seconds. What is the real loss?

    Isn’t it really just about some traders making money at the expense of other traders?

    Why set up a payments system to make this convenient?

    By the way, I think that hand-to-hand currency should be entirely privatized and that the monetary authority should only issue deposit-type liabilities for banks. In fact, I think they should take the form of mutual fund accounts invested entirely in T-bills.

    The reason the monetary authority can control nominal GDP that all of the actual payment signals (mostly electronic, but also paper checks or private paper currency) are subject to being settled with dollar claims by the monetary authority. The monetary auhtority can insist that claims it received be settled with these claims and it can insist that others receiving the dollar payments accept them.

    This doesn’t require that there be any demand to hold these balances in equilibrium.

  54. Gravatar of Major_Freedom Major_Freedom
    15. October 2012 at 12:54

    Gabe gets it.

  55. Gravatar of libertaer libertaer
    15. October 2012 at 14:09

    Scott, great post!

    I remember the first thing I learned from you and Nick Rowe was that monetary policy in principle has nothing to do with either public or private debt.

    If you want the public to understand that, an institution independent both of the state and the banks would be the ideal. That`s why I favor a consumption tax as a vacuum cleaner instead of buying treasuries or private assets.

    Level targeting NGDP through heli drops and consumption taxes would silence any accusation of monetizing the debt, bailing out the banks or helping the stock market.

  56. Gravatar of Major_Freedom Major_Freedom
    15. October 2012 at 15:10

    I remember the first thing I learned from you and Nick Rowe was that monetary policy in principle has nothing to do with either public or private debt.

    You mean monetary policy abstracted from reality, and considered as some ideal type.

    In principle, the Fed was created by the banks and Treasury to benefits the banks and Treasury. The banks and treasury benefit from lender of last resort. If you abstract away from debt, you abstract away from the whole purpose of the bank cartelization.

  57. Gravatar of Major_Freedom Major_Freedom
    15. October 2012 at 15:10

    Level targeting NGDP through heli drops and consumption taxes would silence any accusation of monetizing the debt, bailing out the banks or helping the stock market.

    It would also silence the sole purpose of the Fed.

  58. Gravatar of ssumner ssumner
    15. October 2012 at 17:54

    S. Raven, You said:

    “It is entirely voluntary, and people only take the cash if they want it. What is the difference, what can your monetary authority do to get currency into the system that the Fed can’t do?”

    No they don’t want the cash, but they’ll take it because they can spend it. Suppose I advertise my used car for $8000. I prefer a bank check. Someone shows up with $8000 in cash and I say yes. Now I got $8000 in cash I don’t want, so I spend it. It becomes a hot potato gradually drivng up prices. People want wealth, preferably in convenient forms. But they’ll take cash at some price. Maybe I’ll insist on $8100 for a cash sale, because of the hassle and risk of the cash being stolen. The end result is the same.

    If you’ve never heard of the hot potato theory of money, none of what I say will make sense to you. In that case read Irving Fisher and Milton Friedman.

  59. Gravatar of K K
    15. October 2012 at 19:05

    Scott,

    I don’t believe that if you get an $8000 windfall, that whether or not you spend it will depend on whether it’s cash or a check. Either way you’ll deposit it. The bank will try to unload it ,instantly depressing the interbank rate. If the cb wants to avoid that they’ll do $8k of OMOs. All of which happens immediately, and long before the real economy has any chance to equilibrate in response.

  60. Gravatar of Shining Raven Shining Raven
    15. October 2012 at 23:28

    bill woolsey:

    Thanks for the patient answer. You said:

    “You assume that a bank that fails to settle on demand fails.

    We actually have had laws like that. I think the purpose of such laws was to make failure to pay on demand so costly that banks would hold lots of reserves.

    But the policy was not ever really implemented. It was an empty threat and it was a stupid rule.

    It is much better to have some more modest penalty for banks that cannot pay off on demand.”

    I really do not believe this is how it works. It is not an empty threat, we have not had bank runs in a long time, because there is a lender of last resort. But if banks can be in a position to be unable to make payments, these are once again a distinct possibility.

    I am really not talking about a situation where a regulatory agency enforces something. I am talking about a situation where people have a positive balance in their bank accounts, write a check, and the check does not clear, because the bank has no reserves to settle interbank payments and has no immediate means of obtaining any. This situation obviously has real world consequences for the bank customers who rely on timely payment, and it will get them themselves into trouble with people who expect to receive their payments on time. It is not likely that a bank survives this.

    And I am not talking just about financial high-volume high-frequency trades, although this is obviously where the problem would most likely appear first. I don’t think it is going to be restricted to Wall Street.

    “The reason the monetary authority can control nominal GDP that all of the actual payment signals (mostly electronic, but also paper checks or private paper currency) are subject to being settled with dollar claims by the monetary authority. The monetary auhtority can insist that claims it received be settled with these claims and it can insist that others receiving the dollar payments accept them.”

    I agree with this (well, not entirely sure about the NGDP thing). In my opinion, this means that the monetary authority has to run the interbank claims settlement facility, and has to control the deposits at this facility, i.e. the bank reserves.

    Scott:

    Thanks for the answer, but I don’t agree with your reasoning. I am aware of the “hot potato” mechanism, but frankly I don’t believe that it exists.

    First of all, I do not understand the distinction you make between a bank check and currency. They are both money, bank deposits essentially pay no interest, or close enough to nothing that it makes no difference for an ordinary person whether he has $20 in his account or a $20 bill in his pocket.

    You are not seriously trying to tell me that it depends on whether you get a check or whether you get cash what you do with the money (they are both money)? That you are going to deposit a check in your account, but you are going to blow the cash immediately on purchases of goods and services?

    And then of course anybody who takes cash actually wants cash. If you don’t want cash, you don’t sell your car for cash. I mean, you are free to exchange it for something else, depending on what you want to achieve with the sale in the first place.

    People hold the cash and balances in their accounts that they want to hold. You cannot force them to hold more, they can always convert this to bonds if need be.

    The banking system as such is a different matter, but that is the point: Private non-bank entities are isolated from the Fed by the banking system.

    Also, when private actors sell stuff to one another, this of course has no influence on the amount of reserves in the system, so there is no need to do any OMOs for the central bank if people sell each other cars, at least not when it is only interested in the size of the monetary base, as you want it to be.

  61. Gravatar of Bill Woolsey Bill Woolsey
    16. October 2012 at 03:10

    Scott:

    If someone gives me $8000, I don’t carry it around and spend it because it is a hot potatoe. I deposit it in my bank right away.

    I maybe then spend the money in my checking account more rapidly than usual.

    The actual nominal GDP generating expenditures would be by bank deposit.

    I agree that a monetary authority can control nominal GDP through control of currency. There is no need for regulation of the banking system.

    Well, as long as redeemability is maintainted. That is, banks are obligated to “cash” checks.

  62. Gravatar of Bill Woolsey Bill Woolsey
    16. October 2012 at 03:26

    Shining Raven:

    You keep on confusing systems where currency is issued independent of the banks from systems where the quantity of currency is fixed.

    It is simply false that bank runs develop because of delays in the payments system. Only a few years ago, it took a week for checks to clear. The reason for the delay was to make sure that the depositor had sufficient funds. But that also provides time for banks to raise funds by selling securities or borrowing.

    Bank runs developed historically because banks were thought to be insolvent–not because you have to wait for a ceposited check to clear or because the bank ran out of currency this afternoon,or or because it doesn’t have enough currency to cover a $10,000,000 withdrawal right this minute.

    Delays in clearing is normal and people understand that they might have to wait a bit to get large amounts of money.

    Anyway, the notion that the monetary authority must control the clearing mechanism is false.

    If there is a large increase in the demand for currency, a monetary authority can purchase bonds with newly created currency. Those selling the bonds deposit it in the banks, and so the banks have the currency they need.

    Now, particular insolvent banks will fail. And if all the banks are insolvent at once, then the currency won’t be deposited in banks, and we move to a 100% currency system. That is, all payments by currency. However, in such a situation, rapid reorganization of the insolvent banks making them into solvent banks is a really good idea. Assuming that is done, then we don’t really go to the 100% currency solution.

  63. Gravatar of PeterP PeterP
    16. October 2012 at 05:47

    Good to see Scott Sumner come around to what MMT has been saying: it is fiscal policy, stupid. Helicopter drops suggested here are fiscal policy.
    http://neweconomicperspectives.org/2010/01/helicopter-drops-are-fiscal-operations.html

    W/O the oversight of Congress as proposed here? This ain’t happening.

  64. Gravatar of ssumner ssumner
    16. October 2012 at 06:18

    Bill, The banks also doesn’t want to hold $8000 in cash, so it’s also a hot potato for the bank. The banks spends the cash on interest-earning assets.

    K, I agree, but that doesn’t conflict with what I said. If you “deposit” it, you are spending it on a financial asset. Then the bank will spend it on another financial asset. I agree that spending on financial assets will usually come first, and spending on real assets come slater (in most cases–not hyperinflation.)

  65. Gravatar of Saturos Saturos
    16. October 2012 at 06:28

    PeterP, read this post to get a sense of Scott’s actual position on helicopter drops: http://www.themoneyillusion.com/?p=6119

  66. Gravatar of Saturos Saturos
    16. October 2012 at 06:31

    (That was actually one of my first favorite posts, when I was falling in love with this blog.)

  67. Gravatar of Shining Raven Shining Raven
    16. October 2012 at 06:42

    bill woolsey:

    thanks for your patience, although I still don’t agree.

    “You keep on confusing systems where currency is issued independent of the banks from systems where the quantity of currency is fixed.”

    That may be so, but I am trying to understand how Scott’s proposal would work, and he is not quite saying what the relationship between bank reserves and currency would be.

    Scott said: “The central bank could be an agency that would regulate banks, set reserve requirements, do interbank clearing of funds, be a lender of last resort during banking crises, etc. But not monetary policy!”

    He is not saying what the relation of these reserves to currency would be. This seems to me to be crucial, because otherwise there is no way in which the monetary authority can control the money created by the banks.

    “It is simply false that bank runs develop because of delays in the payments system.”

    That is not what I am saying. I am talking about a situation where the banks cannot obtain reserves to make interbank payments. Not a situation where there is a delay until the next Wells Fargo truck arrives at the branch office.

    Something like this is impossible under the system we have, with insured accounts and a Fed that acts as a lender of last resort. The system as such cannot run out of reserves under the existing policy.

    When this policy is changed, and banks settle through a central bank that cannot create reserves, the situation is of course completely different. It is then completely possible that one or multiple banks can run out of reserves for settlement purposes – and be left without any possibility to obtain reserves, since the banking system as such is short. This is fundamentally different from a situation where the clearing is only delayed.

    Only in a system with a liquidity guarantee does is matter whether a bank is insolvent or illiquid. As a customer, I will not be amused if I cannot access my funds for a month or two until the next batch of t-bills that my bank holds reaches maturity and the bank becomes liquid once more. The bank cannot pay, I don’t care if it is insolvent or illiquid.

    Look, I am coming up with these scenarios because I don’t understand Scotts proposal.

    If any bank can exchange t-bills for cash any time at the monetary authority, I don’t see much of a difference to the current system with its open market operations. So Scott wants something different. I presume this means that the monetary authority will not exchange t-bills for cash at will, but this will be somehow contingent on the amount of currency in circulation. Under such a regime, I see the danger that the banking system could experience liquidity crises. So I want to know how this is supposed to work and if there is some kind of safeguard in Scott’s system.

    And I absolutely disagree with this statement:

    “Anyway, the notion that the monetary authority must control the clearing mechanism is false.”

    The point of monetary policy is to control the supply of money, right? If the banks run their own clearing house, and there is no requirement that they settle in currency (would there be this requirement in Scott’s system?), the could make up their own reserve money, and as soon as the clearing house starts to extend reserve credit to the banks, it has for all intents and purposes become the new monetary authority. It is crucial that the monetary authority is the clearing house, because this is the nexus of the banking system where you can influence the money creation by banks. Scott grants his central bank to be a lender of last resort, so this means it would be able to create reserves for settlement purposes. If this is so, I cannot see what his “monetary authority” can do to restrain money creation.

    Anyway, I don’t have the feeling that I am getting my point across or that I am going to convince anybody. Thanks for engaging with me. I am still curious how the details of Scott’s idea would work, and how the monetary authority “shoves money down the economy’s throat”.

  68. Gravatar of Bill Woolsey Bill Woolsey
    16. October 2012 at 07:07

    Raven:

    The monetary authority would control the nominal anchor becaues the checks written by depositors on bank accounts can be “cashed” for currency. This prevents an inflation of deposit money relative to currency. The opposite is less a matter of contract and more competitive necessity for the banks. If banks accept currency deposits by their customers (because retail customers insist on this) then there is two way convertibility.

    Banks can settle among themselves without using currency if they want, though I think the right of one bank to cash another bank’s check for currency would result in a parellel settlemeent system.

    Allowing banks to insist on settlement with currency and then using some alternative if that is agreeable seems pretty natural to me.

    Sumner has even said in this version of the discussion that any demand for currency by banks counts as a demand for currency like any other, and the monetary authority must satisfy it.

  69. Gravatar of Shining Raven Shining Raven
    16. October 2012 at 07:29

    Bill Woolsey:

    If the monetary authority must satisfy banks’ demand for currency, then obviously there is no liquidity problem.

    However, I see a tension with your first paragraph: How does the monetary authority then “control the nominal anchor”, if it issues cash on demand?

    I don’t disagree with the general proposition, if there is convertibility of deposits to currency this gets the monetary authority’s foot into the banks door.

    But I don’t see how you can resolve the tension between supplying the currency demanded and at the same time keeping control of the amount of currency in circulation.

    I understand how it works in an interest-targeting regime: there is only a “soft” limit on the amount of reserves, and banks can always get more, at a price. If it gets too much for the monetary authority, it simply raises the price.
    It is a “price setter”.

    But again, Scott’s proposal must be different somehow. The amount of currency itself is apparently determined by the monetary authority. So it would be an “quantity setter”. How is this compatible with supplying currency on demand?

  70. Gravatar of Tommy Dorsett Tommy Dorsett
    16. October 2012 at 07:42

    Does any have a non encrypted copy of the paper Scott mentioned: ”
    Financial Intermediation and Price Level Control.” Eugene F. Fama; Journal of Monetary Economics, 1983.

  71. Gravatar of Tom Brown Tom Brown
    16. October 2012 at 10:31

    Scott, when you write “currency” are you referring to only paper bills and coins?

Leave a Reply